Skip to comments.Detoxing the Markets: Bears Still Look Hungry
Posted on 07/16/2002 4:50:49 AM PDT by Lazamataz
Capitulation, my foot.
Monday's trading may have created one of the most gut-wrenching days in stock market history, but it hasn't brought equity values to a bottom. A broad market index like the S&P 500 must slide another 20% or more from here before it is properly valued. Chillingly, even after this year's 30% drubbing, tech stocks must lose half their current value to reach sensible levels.
other words, the S&P and the Nasdaq will both need to drop to around 700 before stocks hit a floor. The one piece of good news is that we're in the last leg of the postbubble correction. But as all action-movie fans know, the last sequence is always the bloodiest. The end is nigh, but it is also in sight. The bad guys in this story are yet to be slain: nosebleed valuations, earnings tampering and a hamstrung macro environment.
(One big caveat: Despite the bleakness of the last few days, stocks almost certainly won't go straight down from here. Recall how long it took for the Nasdaq to hit Detox's target of 1500.)
Despite the selling, a substantial reserve of bullishness still exists on the Street. A clear sign of that is onetime bears like Bank of America's Tom McManus telling people to buy more stocks. Meanwhile, the Fed's monetary policy is extremely loose, and that is keeping the financial system intact -- at least for now. And the selling surely won't be done until we stop hearing the idiotic mantra that equities are cheap because they've fallen so far. On that yardstick, Adelphia, Enron and WorldCom are all screaming buys.
Fundamentals drive markets over the long term, and they still bode ill. Don't be tricked by the argument that because we're trading at close to 15 times expected 2002 earnings for the S&P 500 companies, we must be close to a bottom. Fifteen times is close to the long-term average multiple for the index.
Yes, the index is trading at around 18 times the $51.14 of forecast operating profits. And yes, these may be trough earnings for some sectors. But why are forecast as-reported earnings -- that is, earnings after certain charges and supposedly nonrecurring items -- so much lower at $35.47?
Some of the gap has to do with thedifferent ways that S&P collects as-reported and operating earnings,but it is also because operating earnings generally leaveout goodwill writedowns that have been necessitated by the introduction of a new accounting rule.
Now, there is some argument for keeping a chunk of those writedowns out. But these won't be the last goodwill writedowns we see; as accountants are forced to do their jobs properly, such charges to intangible assets are likely to become a lot more regular. Quite right, these may not be cash charges, but in most cases it took cash to buy or build those assets in the first place.
For those reasons, it makes sense to factor in some of the goodwill charges. Very roughly, that could be done by taking a midpoint between as-reported earnings and operating earnings. That gets us to around $43 in S&P 500 forecast 2002 earnings. Multiplying that by the 15 multiple makes 645 -- close enough to Detox's 700 target for the index.
At the same time, tech stocks have to continue tanking. If we use the S&P 500's information technology sector index as a rough yardstick for tech names, the sector is trading at an absurd 38 times forecast 2002 operating earnings. If we halve that multiple to 20 times, that sector index must also fall by 50%, all else being equal. And 20 times is an aggressive valuation for a sector that is crawling out of one of the biggest busts in history. Apply the halving principle to the Nasdaq and you're at 700 once again.
Of course, any discussion based on earnings assumes we can trust the profits numbers that are reported. As we have seen, that's about as advisable as letting Hannibal Lecter babysit your firstborn. The bulls will retort that once the SEC's deadline passes this fall for CEOs to pledge that their company's numbers are clean, the market will be able to rally.
But who's to say the liars won't keep lying? The wording of the pledge is loose enough to let a top dog weasel his way out if chicanery is exposed later. And even if generally accepted accounting principles are adhered to, the stuff called earnings may bear little relation to what is generally thought to be profits. Actually, it's not even clear that professional money managers know what profits are, given the extent to which postmodern blurriness has infected institutional investors. It's quite mystifying why the head of, say, the Janus Twenty fund hasn't been dragged before Congress for losing billions in mom and pop money. Why the brokers and the accountants and not the people who actually destroyed the wealth?
Completing the nightmare, the Fed can do little more and is looking more and more like the Bank of Japan each day. It has cut rates like crazy and unleashed an unprecedented credit boom -- even in the midst of an economic slowdown, a phenomenon few economists can explain. But this lending bingewon't offer much lasting help, because all it has done is inflate prices in the housing and services sector, shore up demand for autos and make it much easier for the government to suddenly run up a huge deficit. All those uses are consumptive and divert resources from productivity-enhancing investment. What's more, firms are too debt-laden to go back to '90s-level investment spending.
As Alan Greenspan massively raises the supply of dollars, the greenback's price -- surprise, surprise -- is falling against other currencies and gold. It's easy to see why foreigners are heading for the exits: First, in this postbubble, overleveraged environment, the opportunity for good returns has diminished. Moreover, the Fed is deliberately cheapening the dollar that the outsider eventually aims to get paid back in.
But the domestic investor has stayed relatively faithful. Sure, individual flows into the market are way down, but mutual fund flows are still strong, in large part because of the captive 401(k) flows. A reversal of those flows will be the next shoe to drop. And it will trample stocks still further. Capitulation means surrender. And the bears can still safely cry: "No surrender!" Even after a day like Monday.
Actually, their performance is over 3000% from their currency crisis lows. Nevertheless, they have a better economic policy than we do. They learned from the person who defeated them, Reagan. OTOH, President Bush with his Myrmidons in lockstep behind him is undoing everything Reagan did for us economically.
It's a deliberate strategy by the Feds, and it's having the effect described here. The bozo analysts who claim that it's foreigners showing lack of confidence in the dollar are totally clueless.
It will cause inflation eventually. Commodities will notice the effect first, which is why gold is higher and why oil (another international commodity priced in dollars) remains relatively high in a period where there is an actual glut of oil on the market.
These are not conditions that are favorable to a healthy business expansion. It's a transition zone, where the Fed is trying to let the bubble out of the market without sending us screaming into a deep recession.
But make no mistake about it. The bubble is being popped, because it needs to be in order to set us up for another business expansion. People who think this is over, and yesterday's intraday low represent the bottom, simply don't understand the macroeconomics in play here.
Well, this is progress. At least you are now admitting there has been an increase in the money supply, even if you are challenging its relevance.
Now, you tell me: Why do you not think this increase is relevant?
This is on purpose. They are trying to devalue the dollar and reflate the price level in order to offset the deflationary devestation they themselves created with the "strong-dollar"/tight money policy. We need inflation just to get prices back where they should be.
Maybe what's happening has to do with the way people are playing the stock market---partly because they aren't sure where it's going and want to make as much as they can ---I almost wish I had the extra money and time to watch it dip, then buy, watch it rise, then sell. Just to see what I could get out of doing that.
I defer to the hedge fund managers of the world.
From what I gather from your message, you are of the opinion that an increasing money supply is not relevant. Is that a correct statement of your premise?
I will defer to your judgement but some hunch tells me you are erroneous. I'm sure people who are smarter than I will chime in to challenge your premise. I do not have the education or experience to meaningfully challenge it myself.